Contingencies Influencing the Management Accounting Practices of Estonian

Manufacturing Companies

Haldma, T. and Lääts, K. (2002), Management Accounting Research, Vol. 13 No. 4, pp. 379–
400.

Having regained independence in 1991, Estonia has undergone fundamental political and structural
changes over the last decade, which has also affected the operation of its companies. This paper
examines the management accounting practices of Estonian manufacturing companies, exploring the
main impacts on them within a contingency theory framework. The methodology comprises an
analysis of 62 responses to a postal questionnaire survey carried out among the largest Estonian
manufacturing companies. It is comparatively infrequently that Estonian manufacturing companies
have made improvements in their cost accounting methods, although the majority of respondents
appear to acknowledge the importance of these practices in finding and lowering real product costs
and modernising the cost accounting systems. The effectiveness of an accounting systems’ design
depends on its ability to adapt to changes both in external circumstances and internal factors. We have
found some evidence that changes in cost and management accounting practices are associated with
shifts in the business and accounting environment as external contingencies, and with those in
technology and organisational aspects as internal contingencies. On the one hand, the present research
aims to confirm earlier findings related to the ‘contingent factors’ that influence management
accounting, on the other, to identify possible new factors, such as, for example, the legal accounting
environment and shortage of properly qualified accountants.

Keywords: management accounting practice, contingency theory, transition economy, Estonia.

1. Introduction
In the conditions of market economy and intensified competition, the management of a company,
in order to be consciously competitive on the market, needs to have objective information about the
formation and shape of the company’s performance, which is documented in mandatory financial
statements. Therefore, the need for developing such cost and management accounting systems, which
could provide adequate information about main impacts on cost characteristics and companies’
performance, has grown rapidly in Estonia and all the other former socialist countries.
The habitual cost and management accounting practices of Estonian companies can be described,
on the one hand, by the traditions and knowledge that have their origins in their centrally planned
economic background, on the other, by the necessity to solve urgent problems of everyday
management. Hence the management accounting systems (MAS) of the companies operating in the
conditions of transition should provide adequate information, which would help managers take
decisions at different management levels. To be able to make generalisations about the directions of
development of MAS, both researchers and practitioners need more systematic information about the
currently operating cost accounting and management accounting systems and the factors influencing
them. Therefore, the present study is focused on the contingencies that influence companies’
management accounting systems, with a particular emphasis on those operating in the transition
economies. The paper aims to describe the stages and tendencies in the development of the
management accounting issues in Estonian companies, analysing the impacts on MAS by means of
the contingency approach. Considering the enormous changes that have taken place in the social and
economic environments, it will be reasonable to expect significant changes to have occurred also in
the management accounting systems. Thus, besides the description of the situation, the present study
will examine the factors influencing the management accounting systems applied by Estonian
manufacturing companies.
 The paper makes two main contributions to the existing management accounting literature. Firstly,
it has to be admitted that the number of studies focusing on developments in management accounting
in the transition countries is limited, especially such studies that apply the contingency approach.
Thus, at a more general level, our findings may shed light on the development of management
accounting in other developing societies presently undergoing rapid changes. Secondly, we argue that
the environmental aspect affecting the company management accounting system in the initial period
of transition is distinguishable at two levels: the general business (external) environment level and the
legal accounting environment level. Conceptual changes in the legal (financial) accounting level of a
company would therefore serve as a precondition for the design and introduction of its management
accounting area, and consequently the development of its management accounting system.
Although we will examine the management accounting position in Estonian companies, there are
many features of contingencies that have influenced companies in other transition economies in a
similar way. At the same time, our study involves uniquely Estonian features that sets the accounting
issues of the manufacturing companies we studied apart from those of the other transition countries.
The differences result mainly from the different developmental levels of financial accounting and
auditing regulations as a precondition for the design and introduction of the management accounting
area and companies’ MAS.
The paper is organised as follows. The next section is a brief overview of the previous
investigations in the field of management accounting in the transition countries. The third section
outlines the elements of the contingency theory of management accounting, subsequently discussing a
research sample. The fifth section presents our findings on driving forces of the management
accounting practices of Estonian manufacturing companies in four perspectives: catalysts for the
design and formation of MAS; analysis of the role of environmental contingencies in management
accounting practices; analysis of the role of technological contingencies in management accounting
practices; analysis of the role of organisational contingencies in management accounting practices.
Finally, section 6 presents some concluding remarks on the evolution of management accounting
systems in Estonian companies.

2. Previous research in management accounting in the transition countries

Over the last decades, management accounting has emerged as a comparatively popular research
topic in market economy countries. Different surveys on management accounting have been carried
out in several European countries and their results have been reported in various publications
(Bhimani, 1996; Drury et al., 1993; Lukka and Granlund, 1996; Amat et al., 1994).
Analysing management accounting research done in the Eastern and Central European transition
countries on the basis of the publications in Management Accounting Research and The European
Accounting Review, and presentations at the Annual Congresses of the European Accounting
Association, we discovered that in these countries management accounting is still in its initial stages
of development and in the process of developing into a research area in its own right.
During the last eight years (1994-2001) only a small number of papers dedicated to the practice
and development of management accounting in the Eastern European countries have appeared in
Management Accounting Research. Proceeding from the information at the authors’ disposal, there
were only two of them: in 1994 a paper about accounting in an east-west joint venture (Southworth,
1994) and in 2000 a paper about management accounting practices in a Hungarian chemical company
(Vamosi, 2000). The latter discusses institutionalisation aspects of management accounting.
The European Accounting Review has published various papers about accounting and related areas
in the Eastern European countries during the last nine years (1993- 2001). Several publications
address the subject of financial accounting and auditing in Poland, Czech Republic, Romania, etc. In
1995 The European Accounting Review dedicated a special edition to accounting in Central and
Eastern Europe, which comprised an introductory article followed by a number of papers analysing
the characteristic features of development of accounting in Poland, the Czech Republic, the Baltic
States, Hungary, Romania, Slovenia, Yugoslavia, and Russia. All the papers in this edition
concentrated on financial accounting, whereas no aspects of development or practice of cost
accounting and management accounting were even mentioned in the introductory paper (Bailey,
1995). This does not mean that cost accounting and management accounting did not exist at that time
or was not considered to be a research topic at all. The above-mentioned fact merely confirms that the
transition countries prioritised the development of financial accounting, while management
accounting was only in its initial stages of development. The main reasons for that will be analysed
later on.
Yet the authors of the present paper have some evidence that different aspects of management
accounting have been employed and surveyed in some Eastern and Central European countries. An
analysis of the presentations made at the Annual Congresses of the European Accounting Association
between 1993 and 2001 confirmed that at that time in several Eastern and Central European countries
different surveys were made of management accounting practices, particularly in Poland, Yugoslavia,
Czech Republic and Estonia. Nevertheless, the number of the presentations dedicated to issues of
management accounting in Eastern and Central Europe is not large even in comparison with the total
number of presentations about accountancy in Eastern and Central Europe in general. These are
summarised in Table l.

Table 1. Structure of the presentations at the Annual Congresses of the European Accounting Association in
1993-2001
1993 1994 1995 1996 1997 1998 1999 2000 2001

Total number of 236 293 343 352 367 325 388 396 369
presentations
Number of papers 13 21 31 21 21 16 7 12 15
presented by the
representatives of
Eastern European
countries
Number of papers 1 1 4 2 4 4 2 1 2
dedicated to
management
accounting in
Eastern Europe
Number of 1 2 1 0 0 0 0 0 0
symposia
dedicated to
accounting in
Eastern Europe

The number of presentations on accounting in Eastern Europe, listed in Table 1 grew from 13,
made in Turku in 1993, to 31 made in Birmingham in 1995. At the following congresses the number
of papers presented by Eastern and Central European academics and practitioners remained within the
range of twenty. One of the reasons which could decrease the number of presentations from the
Eastern and Central European countries was the fact that since 1996 accountancy in Eastern Europe
has been closed as a topic area for concurrent sessions. At the same time, for example, at the 1994
Annual Congress, where Eastern and Central Europeans presented 21 papers (only one about
management accounting), 25 papers from eight market economy countries directly considered only
activity-based costing (Friedman and Lyne, 1997).
In several European countries different surveys on management accounting have been carried out.
In the Eastern and Central European countries, proceeding from the information at the authors’
disposal, initial surveys of the design of companies’ cost and management accounting systems have
been carried out in Poland (Sobanska and Wnuk,1999; Szychta,2001 etc.) and in Estonia (Haldma,
1997). A comprehensive overview of the research projects and publications addressing the state of
cost accounting and management accounting in Poland in 1993-2000 was given by Szychta (Szychta,
2001).
To sum up, mainly the investigations on management accounting in the Eastern and Central
European countries indicate state-of-the-art-type studies (except Varmosi, 2000). One of the
characteristics of these studies is the fact, that the findings are reported without using any theoretical
framework. In the transition economies, research projects on management accounting practices using
the contingency approach were conducted by Anderson and Lanen (1999, India), and Luther and
Longden (2001, South Africa). Consequently, the development of the management accounting
practices in the Eastern and Central European countries has not yet been studied in detail.

3. The contingency approach framework

The contingency approach to management accounting is based on the premise that there is no
universally appropriate accounting system applying equally to all organisations in all circumstances
(Emmanuel et al., 1990, p. 57). Rather it is suggested that the particular features of an appropriate
accounting system will depend upon the specific circumstances in which an organisation finds itself.
How effective the design of an accounting system is depends on its ability to adapt to changes in
external circumstances and internal factors.
We presume that organisations operate as open systems, being concerned about their goals and
responding to external and internal pressures. The contingency-based approach assumes that
management accounting systems are adopted in order to assist managers in achieving some desired
company outcomes or goals. If a management accounting system is found to be appropriate, then it is
likely to provide enhanced information to the individuals who then can take improved decisions and
thus achieve the organisational goals in a better way.
The major external factors that have been examined at the company level in management
accounting and control (including cost accounting) research are external environment (Khandwalla,
1977; Merchant, 1990; Chapmann, 1997, Hartmann, 2000), and national culture (Hofstede, 1984;
Harrison, 1992; O’Connor 1995). The most widely emphasised research aspects are environmental
uncertainty and hostility. The hardly predictable environmental elements have their own impact on
organisational structure, performance evaluation, budgeting and budgetary control, and are associated
with more open and externally focused financial accounting systems. Environmental hostility from
intensive competition stresses the importance of formal control and sophisticated accounting
(Khandwalla, 1972, Otley, 1978).
The most common internal factors that have been examined in relation to management accounting
are organisational size (Khandwalla, 1972; Bruns and Waterhouse, 1975; Merchant 1981), technology
(Khandwalla, 1977; Merchant, 1984; Dunk, 1992), and companies’ strategies (Miles and Snow, 1978,
Gupta and Govindarajan, 1984; Simons, 1987; Chenhall and Morris, 1995).
As organisations become larger, the need for managers to handle greater quantities of information
increases to a point where they have to institute controls, such as rules, documentation, specialisation
of roles and functions, extended hierarchies and greater decentralisation down to hierarchical
structures (Child and Mansfield, 1972). Khandwalla (1972) found that large firms were more
diversified in product lines, as well as more divisionalised, and employed mass production techniques
and more sophisticated controls. According to Merchant’s study (1981), large companies are more
decentralised and use more sophisticated budgets in a participative way.
Technological contingency factors include the nature of the production process, its degree of
routine, how well means-end relationships are understood and the amount of task variety (Emmanuel,
et al., 1990). More standardised and automated process technologies are served by more traditional
formal management control systems with highly developed process controls (Khandwalla, 1972), high
budget use (Merchant, 1984) and high budgetary controls (Dunk, 1992). Untight use of budgets is less
frequently found in the more predictable and automated process, and will be positively related to less
automated, less predictable job/batch type technologies.
Figure 1 shows the contingency-based theoretical framework. The described process influences the
management accounting practice and effectiveness of performance measurement and evaluation. The
contingencies are divided into two general groups: external and internal factors. External factors
indicate the features of external environment at the level of business and accounting. Environmental
factors impact both on the internal characteristics of an organisation and its management accounting
practice. For example, fierce competition influences the choice of strategy, organisational structure
and also the application of appropriate cost management and control. Internal contingencies are
determined as organisational aspects, technology and strategy. The effectiveness of performance
measurement and evaluation depends on the internal factors and the management accounting practice.
Additionally, feedback from the effectiveness of performance measurement and evaluation of the
management accounting practice can be considered.
 External factors
- Business
environment
- Accounting
environment
Management Effectiveness of
accounting practices performance
- Cost management measurement and
- Budgeting evaluation
- Control, etc.
Internal factors
- Organisational
aspects
- Technology
- Strategy

Figure 1. Theoretical framework of the contingency approach.

Effectiveness can be defined by various measures which all have their advantages and
disadvantages. We defined effectiveness as managers’ satisfaction with their performance
measurement and evaluation.
The list of contingencies and relations in our theoretical framework cannot be considered
exhaustive, since we were unable to identify and include all factors and impacts. Contingency-based
studies assume the existing link between nature, the use of the MAS and subsequently enhanced
performance. At the same time, other behavioural and organisational aspects also influence better goal
achievement (e.g. job satisfaction, working place environment, formal and informal control,
participation in the budgeting process). In the present paper we focus on the following major classes
of contingencies: the external environment, technology and organisational aspects. These elements
and their different impact on companies’ accounting systems are further elaborated on.
Empirical research of contingency theory in management accounting has been conducted at
different levels (industry, firm, units of a firm), considering different contextual factors. The present
study was performed and analysed at the level of a company or major business unit.

4. Research method

Current research builds on contingency theory and exploratory statistical analysis of the factors
influencing MAS in Estonian manufacturing companies. Herein we will review the principles used to
construct the data set for our work.
The empirical data were gathered by a postal survey in 181 larger Estonian manufacturing
companies. To develop an accurate mailing list, each company was telephoned and the names and
addresses of business units were identified, as well as the name of the most eligible person within
each business unit to complete the survey. These were typically financial directors, chief accountants,
management accountants or chief executives. These steps were considered important to increase the
accuracy of the survey responses. In Estonia the survey was pilot tested with a group of chief
accountants and financial directors to refine the design and focus the content. The mailed survey
package included an introductory letter explaining the purpose of the research, a copy of the survey,
and a pre-paid envelope - for returning the survey. The study aimed at the design of cost and
management accounting systems in Estonian companies and was carried out in 1999. The mailing
resulted in 62 usable responses or a 34.3% response rate. It seems to be acceptable, compared to other
surveys carried out in the area (Kind, 1985; Reichmann and Kleinschnittger, 1987; Drury et al., 1993;
Andersen and Rohde, 1994).
On the basis of the returned surveys a statistical analysis was carried out, using one-way analysis,
two-way analysis and Fisher's Exact Test.
The responding companies in Estonia represented 15 different branches of manufacturing, such as
energy supplying, wood industry, food industry (covering dairy, meat, fish, tobacco products and
drinks), chemical, metal, textile industry, etc. The predominant industries were food industry
represented by 15 companies, textile industry by 10, and wood industry by 8 companies. A smaller
number of companies represented other branches of industry.
The population for the study comprised the country's largest manufacturing companies. Therefore,
the findings of this study are related to the largest manufacturing companies and should not be
interpreted as relating to the general population of manufacturing companies. In as much as size is
associated with the availability of resources to experiment with a range of management and
accounting practices, it is likely that the sample included a greater proportion of companies employing
"advanced practices" than the total population of manufacturers. Hence, the study has its limitations if
we want to generalise the results to all manufacturing companies in Estonia.
The categories of information that have been included into the survey cover the following aspects
of MAS: background, cost measurement and appraisal in financial accounting, cost element
accounting, cost centres accounting, costing methods, pricing principles, budgeting, and internal
performance measurement systems.

5. Analysis of the contingencies influencing the development of management accounting

systems
5.1. Conceptual changes in the Estonian companies’ management and cost accounting patterns
during the period of transition.

The process of development and implementation of cost accounting and management accounting
systems in Estonia can be characterised by a competition between the traditional customs and
knowledge having their origins in the country’s centrally planned economic background, on the one
hand, and the need to solve urgent everyday management problems, on the other. In centrally planned
economies companies never had to face such commercial problems as, for instance, what products
should be produced or on which markets they should be sold to bring them into profit. Decision-
making was highly centralised and accounting information was considered significant neither in the
decision-making process nor for performance evaluation. The income statement used at that time was
based solely on the ‘cost by nature’ format. As product prices were fixed by state officials, companies
had to produce accurate information, especially about their production costs. As a consequence of the
unified measures adopted by the State (based on a unified chart of accounts applied by all Soviet
companies), full costing became compulsory for all industrial enterprises. The full costing approach
was also supported by academics. A view was spread, according to which the product cost had to
include both manufacturing and selling costs and all the other expenses of the company (Petrova,
1986, p.8). Enthoven has pointed out that in the conditions of a centrally planned economy, cost and
management accounting were not treated as independent branches, but as integral parts of unitary
financial accounting (Enthoven et al., 1993).
Under a centrally planned economy, several aspects of cost accounting were introduced by
Estonian companies, but this served the objectives of financial accounting, statistics and centralised
management. At that point, we fully agree with Enthoven. However, it has to be admitted that in the
highly centralised decision-making framework, flexible rearrangements in the companies’
management systems of external environmental impacts were not needed. Therefore, we argue that
within the Soviet accounting framework, management accounting existed in a very narrow sense.
Hence, during the first stage of transition, the MAS was a conceptually new issue in the development
of the companies’ accounting system whose design and introduction necessitated a conceptual change
in the thinking of the companies’ financial personnel.
The first step towards the formation of a market economy accounting environment in Estonia was
made as early as 1990 when the Estonian Regulation on Accounting was passed. This regulation
marked the first attempt made in the country to establish a legal basis for accounting requirements
consistent with the internationally accepted accounting principles. As pointed out by Bailey (Bailey et
al., 1995, p.688), this event marked the beginning of the spread of disharmony in accounting on the
territories comprising the USSR. With regaining independence in 1991, the economic situation of
Estonia changed dramatically. Besides other transformations, an entirely new role was attributed to
accounting by the market forces. The need to create and develop conceptually different management
accounting systems was growing rapidly. In 1992-1994, the Estonian universities incorporated
management accounting into their curricula as a separate discipline. The above-mentioned Regulation
on Accounting was in force from 1991 to 1994. At that time, the official income statement format was
based on ‘cost by nature’ since the full costing approach maintained its monopoly position. But the
new competitive environment generated a market-based need for variable costing. Prompted by the
changing needs of companies, cost accounting started to expand, as a result of which management
accounting emerged.
While in the market economy countries the fundamental nature of management accounting
systems and practices has remained the same throughout the last decades (Drury et al., 1993), the
application of accounting within the management process has changed to some degree (Bromwich and
Bhimani, 1994). At the same time, both accounting as a whole and financial as well as management
accounting in Estonia and the other transition economies underwent evolutionary changes in the first
half of the 1990s.
The next, even more substantial and complex step in the accounting reform of Estonia relates to
the Estonian Accounting Law (EAL), which came into effect in January 1995. Since its enforcement,
the concepts of financial accounting that Estonian companies are guided by have improved
essentially. In accordance with the EAL, companies can now use one of the two income statement
formats: either the ‘cost by nature’ format (already introduced by the Regulation on Accounting) or
the ‘cost by function’ format (which was new to the accounting practices of Estonia). In addition to
establishing the legal accounting framework, the law urged companies to improve their cost
accounting and management accounting systems.
The implementation of the ‘cost by function’ income statement format changed the widely spread
understanding about some aspects of cost accounting, e.g. the essence and the formation of product
unit cost. The EAL specifies that selling expenses, administrative expenses, research and development
expenses are period expenses (Estonian Accounting Law, 1994, p. 34). These expenses should not be
included into the values of inventories and are, therefore, not part of the cost of goods sold in the ‘cost
by function’ income statement format. Nor do they belong to product unit costs. Consequently, as the
EAL states, the values of inventories and the cost of goods sold should be based on manufacturing
costs. This is a conceptual difference in comparison with the full costing methods characteristic of and
solely used by a centrally planned economy. Although the law stipulates no systematic requirements
for companies’ cost accounting systems, the implementation of the ‘cost by function’ income
statement format made it necessary to pay more attention to objective cost allocation methods in order
to receive more objective information for product-mix decisions, profit budgeting and profit-
conscious pricing.
74% of the respondents of the survey had made changes in different cost aspects concerning their
accounting systems in the years 1996-1999. Half of the respondents had planned to make such
changes in their cost accounting system which would yield more detailed and segmented cost
information. Among the main areas needing improvement, the following were pointed out: the
companies’ cost allocation methods, the product costing methods, the implementation of variable
costing with the contribution margin approach, and the introduction of the activity-based costing
system.
The respondents to our survey admitted that mainly two driving forces had made them develop
their companies’ cost accounting systems, namely, the need for more detailed divisional (segmental)
performance information (66% of the respondents) and changes in the organisational structure (42%)
(see Table 2). Thus, the growing market pressures have raised the companies’ awareness about the
need for more detailed cost information. Such catalysts as changes in production technology and
market structure had comparatively less influence on the improvements made by the companies in
their cost accounting systems (see Table 2).

Table 2. Factors prompting changes in cost accounting systems in 1996-1999

 Factors Number of %
companies
Need for divisional (segmental) 41 66
performance information
Changes in organisational structure 26 42
Changes in production structure 16 26
Changes in production technology 10 16
Changes in market structure 8 13
Other reasons 6 10

Subsequently, we will try to set the expanded list of causes into the contingency approach
framework. In the survey, we asked the respondents to indicate on a five point scale what significance
any of the catalysts had had on the improvement of their cost accounting and management accounting
systems.
Table 3 describes the drivers that have either sped up or slowed down the transformations in the
Estonian companies’ cost and management accounting systems. While all of them had a generally
positive (i.e. speeding-up) influence, the most forceful among them were the need for more detailed
divisional (segmental) performance information, availability/non-availability of competent financial
staff, changes in the managerial practices, and advances in information technology. According to
Table 3, among the other drivers the change of production technology and the impact of retraining
programmes had the lowest standard deviation and a tendency to spread, in the respondents’ opinion.
The opinions differed most about how the level of satisfaction with the performance measurement
systems influenced the change of the accounting systems.

Table 3. Drivers that have slowed down or sped up changes in accounting systems (1– slowed down
significantly, 2 – slowed down to some degree, 3 – no effect, 4 – sped up to some degree, 5 – sped up
significantly)
Drivers of cost and management accounting change Contingency Mean Stand.
characteristic* Deviation
Need for more detailed divisional (segmental) OA 4.36 1.12
performance information
Availability of competent financial staff OA 4.25 0.81
Changes in managerial practices OA 4.07 1.02
Advances in information technology OA 3.91 1.17
Tightening competition E 3.84 1.07
Changes in the organisational structure OA 3.70 1.01
Impact of retraining programmes E 3.56 0.76
Dissatisfaction with the performance measurement OA 3.52 1.23
systems
Change of production technology T 3.48 0.72
Change of production structure E 3.44 0.89

Benchmarking of cost and management accounting E 3.39 0.82

methods
Change of the market structure E 3.36 0.82
* E - environmental aspect
OA – organisational aspect
T- technological aspect of a company

The driving forces behind the emergence of cost accounting and management accounting (see
Table 3) reflect different environmental, technological and organisational aspects of the companies’
accounting patterns. Therefore, in what follows they will be regarded as the contingencies that
influence cost and management accounting in the Estonian manufacturing companies.

5.2. Impact of environmental aspects

 The environment is a term used to explain a number of facets. Relevant features of an
organisation’s environment which affect the design of its accounting system include the degree of
predictability, the extent of competition faced on the market place, the number of different product-
markets faced by a degree of hostility (price, product, technological and distribution competition)
(Emmanuel et al., 1990, p. 57). It is suggested that increasing structural complexity will lead to the
addition of new accounting tools to those already in use.
Considering the above-mentioned role of financial accounting in the formation process of the
accounting framework during transition, we argue that the environmental aspects affecting
companies’ management accounting systems in the initial period of transition can be distinguished at
two different levels:
1) the general business or external environment level and
2) the legal accounting environment level.
The external environment will affect the nature of the accounting system, for any particular
accounting system chosen aims to facilitate the company’s adaption to the environment it faces. In the
course of transition from a centrally planned to a market economy, a company’s accounting system is
affected by two mutually connected changes related to the ways they utilise accounting information
(Alver, J. et al, 1996, p. 3):
1) a change from the state to the business community as the primary user;
2) a change from the passive role to an active role in the stimulation of economic activity.
In the second half of the 1990s, the development of the general business environment in Estonia
was affected by the following events:
 conceptual changes in the regulatory context (enforcement of the Accounting Law in January
1995 and of the Commercial Code in September 1995, etc.);
 ownership changes (the most intensive period of privatisation was 1993-1995);
 development of the capital market (the Tallinn Stock Exchange opened in May 1996);
 recession on the Eastern markets (the Asian crises in 1997, the Russian crisis in 1998).
In the main, these systematic factors had an indirect impact on the companies’ management
accounting system; but the above-mentioned recession on the Eastern markets tightened the
competition on the domestic markets. Increased competition and raised production quality standards
required adoption of a more sophisticated and market-sensitive internal management accounting
system.
From the list of drivers given in Table 3, the following items indicate what environmental aspects
influence the accounting system:
 the need for a more detailed divisional (segmental) performance information;
 tightening competition;
 change of production structure;
 benchmarking of the cost and management accounting methods;
 change of the market structure;
 retraining programmes.
A more competitive marketplace, its greater dynamism and heterogeneity, and a more intensive
operating environment all broadly suggest that the accounting system should become more
sophisticated and complex, and capable of evaluating managerial performance in more varied ways.
The need for more detailed divisional (segmental) performance information reflects both
environmental and organisational aspects of impacts on management accounting, depending on a
particular performance unit involved. In our conception performance units such as product groups,
client groups, sales regions, etc. reflect environmental aspects, while such performance units as
organisational units reflect an organisational aspect. Concerning the environmental aspects, more than
a half of the surveyed companies based their performance measurement on the product groups (52%
of the respondents), much fewer on their client groups (20%) and quite few on the sales regions
(17%). The main part of the companies monitored and evaluated the profits and profitability measures
of different internal business units and products or product groups, while only a few companies stated
that they measured the profitability of their client groups and sales regions. Consequently, the
companies’ performance measurement system was manufacturing-oriented rather than market-
oriented.
 Tightening competition; changes both in the market structure and in the production structure
precipitated the need for a market-sensitive attitude in performance measurement and for receiving
objective and appropriate cost information about different cost units (cost objects). No longer could
the companies expect to cover costs automatically, simply by engaging in full cost accounting or by
charging their customers a full-cost-based price. A challenge for variable costing had emerged.
A comprehensive cost accounting system serves as a basis for understanding the process of cost
formation in the companies’ value chain, in order to analyse and manage cost behaviour. Cost
accounting generally includes four broad areas: cost elements (types) accounting; cost centre
accounting; cost objects (cost units) accounting, and operative performance measurement (Mayer, et
al., 1994). Although there has been a big change in perceiving the role and relevance of cost and
management accounting, the managers of Estonian companies still interpret their objectives, methods
and influence on management decisions in differing ways.
The majority (80%) of the companies divide their costs into manufacturing and non-manufacturing
ones, 58% into variable and fixed ones, and 75% of the companies into direct and indirect ones.
Although in formal terms cost analysis has been widely introduced, many companies have chosen
overly broad accounting segments and units. The analysis of direct-indirect costs was carried out
mainly within an organisational dimension and that of variable-fixed costs within a product
dimension. On the issues of cost accounting the survey yielded the results shown in Table 4.

Table 4. Principles and methods used in product costing by the Estonian

manufacturing companies
Product Costing Principles Proportion (%)
(N=62)
Full costing 54.8
Variable costing 38.7
Variable costing and full costing 6.5
Product costing methods Proportion (%)
Process costing 51.3
Job-order costing 33.7
Both 15
Activity-based costing 7

Concerning the principles of product costing, our survey indicated that 54.8% of the companies
follow the principles of full costing, 38.7% those of variable costing and 6.5% both of them. From
among the product costing methods 51.3% preferred process costing and 33.7% job-order costing,
while 15% of the companies used both methods. In our estimation, only 7% of the respondents use
activity-based costing (ABC).
Our survey indicated that manufacturing overheads were usually allocated on a volume basis. As
the main allocation bases, direct labour costs (42% of respondents), sales volume (38%), direct labour
hours (28%), direct materials (26%), machine-hours (16%) and the number of operating cycles (8%)
were used. Non-manufacturing overheads were usually assigned according to the manufacturing costs
of the products, to a lesser degree according to sales volumes. Our survey also indicated that 50% of
the companies used up to two and 70% up to four different allocation bases. In most companies direct
costs are not connected with technological maps of the manufacturing process, which implies an
arbitrary choice of cost allocation rates. Unfortunately, such a limited approach could not yield a
comprehensive picture of the cost formation process in manufacturing.
 To measure the operative performance of different operating segments, internal reporting systems
had been introduced by 82% of the responding companies. A large number of the companies,
however, compiled their internal performance reports on the basis of their financial accounting
statements. The ‘cost by nature’ income statement format was used by 48% and the ‘cost by function’
format by 52% of the respondents. Both formats were used by four companies (6%). Variable costing
with the cost-volume-profit analysis offered a convenient and more objective way to get an idea about
the cost formation process in manufacturing, to fix the price ranges and to realise an active pricing
policy. However, in parallel with the above-mentioned income statement formats, a couple of
companies have used the contribution margin approach, although to a limited extent. 21% of the
companies prepare their internal income statements according to the multi-step and 28% according to
the single-step contribution margin approach. This tendency shows that the Estonian companies’
management accounting systems have to provide more detailed cost information in order to help
managers to take decisions and manage performance. There is an interaction between the external and
internal aspects of reporting: objective information about the cost of activities, products, services, etc.
serve as a foundation for an adequate evaluation of the cost of the goods sold and inventory.
Consequently, cost accounting serves as an information basis for the performance measurement
systems.
The development of cost accounting and management accounting, and the application of the
variable costing and contribution margin approaches in performance measurement are more
associated with the efforts of academics and consultants than those of practitioners. In the mid-1990s,
most active practitioners in the field of accounting had been trained in the conditions of a centrally
planned economy. As mentioned above, a full costing approach could not provide the management
with objective information on costing, pricing and cost management. Our interviews in the companies
revealed a critical shortage of competent financially trained staff. Academic knowledge of accounting
was infiltrating into the cost accounting and management accounting practices of the companies little
by little. Thanks to the companies’ close contacts with the teaching staff of accounting in the
educational establishments, seminars were held for the top management and employees in
accountancy. This helped to transmit new ideas and techniques into the actual practice.
Regarding the legal accounting environment as a driver influencing the development of cost and
management accounting, we suggest that this is a characteristic feature of the transition economies.
Our suggestion rests on the following conceptual moments. Among the other improvements made in
accounting during the transition period, the first priority was given to financial accounting. This
approach was justified, as it was first and foremost necessary to guarantee that the companies’ of the
country would be able to prepare their financial statements in compliance with the Estonian
Accounting Law (EAL) and the generally accepted accounting principles. After the EAL was
enforced, the companies were required to conceptually redesign their financial accounting systems.
The idea that the companies should carefully observe the stipulations of the EAL was adamantly
supported by the “big six” auditing companies operating in Estonia. On the other hand, the
compulsory reconstruction of their financial accounting systems did not let the companies pay enough
attention to the improvement of their internal accounting systems (including cost accounting,
management accounting, management control, etc).
Proceeding from the previous statements, we argue that the conceptual changes in financial
accounting characteristic of the Eastern and Central European transition countries served as a
precondition for the design, introduction and improvement of cost accounting and management
accounting, and the development of companies’ management accounting systems. Market economy
countries have not experienced such a conceptual change in financial accounting in such a short time
during the last decades. We support Virtanen et al. (1996) and Scherrer (1996) who say that the
evolution of financial accounting has influenced the development of cost accounting and management
accounting.
Studying the classification of the expenses in the chart of accounts, it becomes evident that in
1990-1995 the most frequently used classification was based on ‘cost by nature’, whereas since 1995,
the classification based on ‘cost by function’ has been preferred. For example, the expenses
classification based on ‘cost by function’ was used by 13% of the respondents in 1996 and by 60% in
1999. This can be viewed as a conceptual change. Wider implementation of cost classification and the
‘cost by function’ format of the income statement induced a debate about the allocation methods of
fixed overhead costs used by Estonian companies. This opened the way to improving the cost
allocation and product costing methods, the implementation of variable costing with the contribution
margin approach, and the introduction of the activity-based costing system. But 65% of the companies
were still using the ‘cost by nature’-based classification and a quarter of the respondents were using
both classification bases simultaneously. However, 53% of the responding Estonian companies
included non-manufacturing costs into product costs. A large majority used the ‘cost by nature’
income statement format.
The accounting framework and the procedures to be followed by Estonian companies and
institutions are legally regulated by the following:
- the Estonian Accounting Law (EAL);
- the accounting standards issued by the Estonian Board of Accounting Standards.
In a certain sense, this concept is unique, and appeared to have a number of advantages in the early
history of the regulation of accounting (the transition period), enabling the country to carry out the
transition process in a flexible manner. Since 1995, 16 accounting standards (EASs) have been issued
to improve particular aspects of accounting in Estonia. The valuation of the cost of goods sold and
inventory items are regulated by the following EASs: EAS 6 - Balance Sheet Accounts (in compliance
with many IAS standards, such as IAS 2, Inventories, IAS 16, Property, Plant and Equipment, etc.),
EAS 7 – Income Statement Accounts (in line with IAS 8, Net Profit for the Period, Fundamental
Errors and Changes in Accounting Policies), EAS 14 – Segment Reporting (in compliance with IAS
14, Segment Reporting). Consequently, the pressure from the legal accounting environment to
improve the methods of cost allocation and product costing, on the one hand, and cost accounting, on
the other, serve as an information basis for compiling true and fair financial statements.

5.3. Impact of technological aspects

It is argued that the production process will affect the selection of the type of costing system. A
production facility that produces individual products to specific criteria will require a very different
costing mechanism to the one that is geared up to mass production with high joint fixed costs.
Due to product inter-dependence, there is a technological constraint on the design of an accounting
system. New technology will evidently lead to a change in cost structures. Therefore, while the
technological progress continues, the accounting system might probably become more complex and
sophisticated, and capable of following cost appearance in the manufacturing process more precisely.
From among the drivers of cost accounting and management accounting given in Tables 2 and 3 the
change of production technology reflects a technological feature. As mentioned above, this factor
failed to have a sufficient impact on the companies’ accounting practices in Estonia. However, the
tightening global competition and increasing fixed costs associated with the use of advanced
manufacturing technologies have prompted the need to analyse, allocate and manage fixed costs
better. In 63% of the responding companies the share of manufacturing overheads in the
manufacturing costs was up to 30 %, while in 11% of the companies it exceeded 50%. 13% of the
companies, unfortunately, were not used to distinguishing the manufacturing overhead costs.
Detailed cost centres accounting helps us to understand where the costs appear and to clarify the
connections between the costs and cost objects. An analysis of the implementation of cost centres
revealed that 72% of the companies have introduced cost centre accounting. At the same time,
manufacturing overheads are measured in the cost centres at the equipment level by 14% of the
companies, at the production line level by 27%, and at the sub-unit or company level by 59% of the
companies. These results indicate that manufacturing overheads are broadly defined, which in the
future may raise potential difficulties when trying to relate these costs with their cost objects
(products), and may cause problems in the whole product costing area. It is apparent that the
application of cost centre accounting tends to increase in line with company size. As indicated by our
survey, 90% of the companies whose sales volumes exceeded 6.5 million euros applied cost centre
accounting, while only 59% of the companies with smaller sales volumes did so. Our study revealed
no clear distinction in the MAS design among different production technologies. The allocation of
maintenance department costs among production cost centres was in 47% of the cases based on a
company-wide rate and in 26% of the cases on a plant-wide rate. Such behaviour refers to inaccurate
information about the consumption of these supporting services by the manufacturing process of the
particular products. In order to get objective cost information and avoid potential problems, the
companies would need to use more specified cost drivers.

5.4 Impact of organisational aspects

From the list of drivers in Table 3, the following items reflect the organisational aspects
influencing the accounting system:
 Need for more detailed divisional (segmental) performance information;
 Availability/non-availability of competent financial staff;
 Changes in managerial practice;
 Advances in information technology;
 Changes in the organisational structure;
 Dissatisfaction with the performance measurement system.
These have been the most crucial drivers speeding up the changes in the management accounting
practices of the Estonian manufacturing companies. Among these the need for more detailed
divisional (segmental) performance information had the strongest influence on the changes in the
MAS. As mentioned above, the need for more detailed divisional (segmental) performance
information reflects both environmental and organisational aspects of impacts on management
accounting, depending on the performance unit involved. Such performance units as product groups,
client groups, sales regions etc. indicate environmental aspects in our conception and their impact was
analysed in part 5.2. Organisational units as performance units reflect organisational aspects. In most
companies (68%) performance measurement is based on different operating segments or divisions.
The majority of the companies monitored and evaluated the profits of different internal business units
and products or product groups, only a few companies stated that they measured the profitability of
their client groups and sales regions. 74% used profitability as a performance measurement indicator
and 26% did not measure profitability at all. The profitability calculations were predominantly based
on the profits of the business units and products.
We divided our research population into two groups: smaller companies with sales less than 13
million euros and bigger companies with sales over 13 million euros (see Appendix 1). As a rule,
smaller companies preferred to prepare and use budgets for the company as a whole (92%). Only 47%
of these companies prepared budgets for internal business units and 51% applied more detailed cost
budgets. The performance measurement and variance analysis between the budgeted and actual results
was also carried out at company level, and to a lesser extent at internal business units level.
Larger companies used more sophisticated budgets. They all composed budgets for internal
business units and 90% of them used more detailed cost budgets. They used more sophisticated
performance measurement systems (e.g. for evaluating the performance of different products or
business units, but also that of different regions or customer segments). This result supports the
findings by Merchant (1984), according to whom it is large companies that use more sophisticated
budgets.
Internal performance measurement and reporting systems were introduced in 82% of the
responding companies. Nevertheless, most of the companies used the financial accounting statement
formats as a source for internal reporting. The contribution margin approach was applied to a lesser
extent. There was a difference between larger and smaller companies: 50% of the bigger and 18% of
the smaller companies applied the contribution margin approach in their internal reporting.
It is apparent that the level of sophistication of a cost accounting system tends to increase in line
with company size. Our survey indicated that larger companies were more inclined to record their
costs at production line and equipment level, while companies with sales revenues under 13 million
euros evaluated their costs at company or department level.
Luther and Longden (2001) found a positive relationship between pressure exerted by controlling
shareholders and management accounting change. All the companies involved in our sample (62
companies) were private companies. In our survey we distinguished between three groups of
companies on the basis of their independence concerning the design of their internal accounting
systems and foreign capital involvement:
 Single companies (incl. parent companies) which were responsible for and independent in
designing their internal accounting system (incl. cost accounting, internal performance measurement,
etc.) – 36 companies (58% of the population). In this group, only in two companies the majority of
shares was owned by foreign capital (5.5% of the group population).
 Subsidiaries of the group which were responsible for and independent in designing their
internal accounting system – 15 companies (24.3% of the population). In eight companies the
majority of shares was owned by foreign capital (53.3% of the group population).
 Subsidiaries of the group in which the design of their internal accounting system was
regulated by parent companies – 11 companies (17.7% of the population). In ten companies the
majority of shares was owned by foreign capital (90.9% of the group population).
We analysed these companies’ cost accounting and management accounting aspects, considering
their independence in designing their internal accounting systems and foreign capital involvement in
them, on the one hand, and implementation of more advanced cost accounting and management
accounting approaches (variable costing, the contribution margin approach, activity-based costing), on
the other. We did not get any clear evidence to support the idea that shareholders’ pressure and
foreign capital involvement actually directly affect the designing of accounting systems. Only in one
aspect certain evidence was found. In 46% of the companies, the subsidiaries of the group which were
independent in designing their internal accounting system (second group) implemented variable
costing (on average in 38.7% of the companies). However, concerning the ownership aspect (foreign
capital involvement), no difference was revealed between the companies’ MAS design.
The companies which implemented the variable costing and the contribution margin approaches
ranked such drivers of management accounting as ‘availability/non-availability of competent financial
staff’ and ‘changes in managerial practice’ highest. This may be attributed to increased application of
modern management techniques as a result of increased awareness, education and retraining
programs. On the other hand, the shortage of qualified accountants may serve as a crucial aspect, as
far as application of contemporary management accounting techniques is concerned.
In internal reporting the main accent has been stressed in monthly and annual reports.
Additionally, companies also prepare the operating cost reports according to the organisational
structure. The results indicate that half of the companies used different principles when designing
their budgets and internal reports. All the companies with sales over 13 million euros stated that they
prepared budgets for business units using the contribution margin approach, but only half of them
evaluated the performance in the reports according to the same principle. Among the smaller
companies, the contribution margin approach was used in budgeting by 46% of the companies and in
internal performance measurement (reporting) by 19%. The insufficiently related budgeting and
reporting systems indicate that many companies do not use accounting information systematically for
clear and useful purposes. This may raise serious problems for managers who plan and control their
companies’ performance.

5.5 Need for further improvements

The areas of cost accounting and management were highly important issues for 70% of the
companies, whereas 5% of the respondents found that these areas had no significance for them.
As mentioned above, dissatisfaction with the performance measurement system, which was unable
to provide appropriate information for decision-making, served as a significant catalyst in improving
the cost accounting and management accounting systems. In the survey we requested the respondents
to assess on a three-point scale their degree of contentment with their companies’ performance
measurement system. Among the surveyed population, 20% of the companies stated that they were
satisfied, 68% were partly satisfied and 10% were dissatisfied. There was no clear difference between
the performance measurement satisfaction of smaller and larger companies. All the companies, whose
managers stated that they were satisfied with the performance measurement, used more
comprehensive cost budgets, but only 27% of them had integrated similar approaches in budgeting,
performance measurement and reporting. The dissatisfied companies had applied no internal
budgeting or performance measurement at all. Consequently, there is a need for certain improvements
to be made in the companies’ cost accounting and management accounting systems.

6. Conclusion
 The present study shows that the contingency framework helps to structure the impact of various
drivers upon the design and use of cost accounting and management accounting systems in transition
economy.
By exploring the drivers of accounting in Estonian manufacturing companies we may have
succeeded in shedding some light on the role of management accounting in companies of transition
societies. Our research confirms some prior findings related to influencing contingencies, such as
tightening competition and organisation size, and introduces possible new drivers, such as the legal
accounting environment and shortage of qualified accountants. These features are characteristic of
transitional countries. Subsequently we conclude that the conceptual change in the area of financial
accounting characteristic of the Eastern and Central European transition countries served as a
precondition for the design and introduction of management accounting and for the development of
companies’ management accounting systems. Market economy countries have not experienced such a
conceptual change in financial accounting within such a short period of time.
Our study, which analysed the development of management accounting in Estonian manufacturing
companies by means of the contingency approach, revealed the following issues:
 Broadly defined cost centres may raise potential difficulties in relating different cost elements
with the cost objects (products), and hence problems will occur in the whole product costing area;
 There was no clear distinction between the management accounting system designs of
different production technologies;
 Most of the companies used the financial accounting statement formats as a source for
internal reporting;
 The insufficiently related budgeting and reporting systems indicated that many companies
failed to use accounting information systematically for clearly defined and useful purposes;
 In most companies, performance measurement was based on different functions and product
groups, to a lesser extent on client groups and sales regions.
Finally, we would like to admit that this exploratory study has certain limitations. First, it has a
static character. It would be useful to expand the survey on more longitudinal aspects and
management accounting change, on the one hand, and on specific management techniques in a more
detailed way, on the other. Secondly, we recognize that the comparatively low number of responses to
our questionnaire survey may have caused a bias.

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Appendix A

Net sales of the surveyed companies

Net sales Number of % Cumulative Cumulative %

(million euros) companies frequency
Up to 3.7 15 25.2 34 38.7
3.8 – 6.5 19 30.6 34 54.8
6.6 - 13 17 27.4 51 82.3
13.1 - 32 8 12.9 59 95.2
Over 32 3 4.8 62 100